Educational Articles

Industry Analysis: Funeral Services

Matthew Spencer

Companies in the Funeral Services Industry are often viewed in an unpleasant light, but the products and services they provide are necessary. The morbid nature of the business does not mean that individuals can't profit from investments here.

Members of the industry can loosely be classified under three categories: cemetery owners and operators, funeral homes, and manufacturers of burial and memorial products. Still, it is common for companies to span multiple lines of business, combining, for example, funeral home and cemetery operations.

This is a mature industry. Revenue are determined by the death rate, incremental price increases, product mix, and conditions in the broader economy. Consequently, investors looking for above-average revenue and earnings growth ought to look elsewhere. However, what the industry lacks in growth prospects, it makes up for with stability. Demand for funeral services is inelastic, making the group recession resistant, though not recession proof. Business tends to be consistent, but there is a degree of seasonality in results, with revenues and earnings highest during the winter months, when influenza and pneumonia cases peak. (International operations are not significant.)

Although the Funeral Services Industry is stable, and its long-term prospects are buoyed by the aging baby-boom generation, it still faces challenges. One of the biggest obstacles is the movement away from traditional burials toward cremation. This trend has been going on for years at a slow, but steady, pace. Cremations produce lower revenues and profits than burials.

Funeral Homes

Funeral home operations are the most diverse subsector of the industry. They act as retailers for burial and memorial products, prepare bodies for cremation or burial, provide space for memorial services, and coordinate various other aspects of the cremation or burial process, depending on the wishes of the family or the deceased.

Revenues fall into two categories, pre-need and at-need. Pre-need revenues are created when funeral service plans are made in advance, while at-need business stems from family members making arrangements after a loved one has passed. Funeral home business is highly dependent on the death rate, although economic factors do come into play. When the economy is strong, pre-need revenue is more plentiful, and consumers are willing to purchase high-end burial and memorial products, which usually carry richer margins than their basic counterparts. In challenging economic periods, revenues are more dependent on the death rate, and operating variables, such as mix and labor costs, have greater influence on margins.

Cemeteries

Cemetery operations include sales of interment rights and burial and memorial products, along with grounds maintenance. An interment right gives a customer burial space and perpetual care of that space. As is the case in the funeral home segment, sales here are either pre-need or at-need, with the former showing greater strength during times of economic prosperity. Pre-need sale proceeds are put into merchandise and perpetual-care trusts, and held until services and products are delivered. In the interim, a cemetery operator can collect investment income on the funds.

As well, cemetery revenues are positively correlated with the death rate, which is the dominant factor that drives demand. Companies can push products and services, but there are limits to how much business they can capture. Profitability depends on a variety of factors, such as labor costs and the prices of commodities, e.g., gasoline.

Manufacturers

These are the companies that make the burial and memorialization products typically sold through retailers and funeral homes. The offerings include caskets, urns, headstones, etc. Like the rest of the industry, manufacturers' results are dependent on the death rate and the economy, and it is difficult to drive growth. A higher death rate obviously translates into increased sales, and a robust economy typically means that people are willing to spend extra money on ornate offerings, which usually carry higher margins than pedestrian products.

While top-line results are influenced by economic conditions, managers play a greater role in determining bottom-line performance. Sales and the product mix have a significant impact on earnings, but there are other factors. For instance, efficient operations, supported by, say, lean manufacturing techniques, are necessary to support margins. Movements in the commodities markets drive input costs up and down, but managers have sway here, too, given their ability to lock in prices for raw materials over a particular duration.

Conclusion

The Funeral Services Industry is best suited to investors looking for stability and income. Death is one of life's few certainties, so these companies have a steady flow of business, despite a degree of seasonality. However, this is not a growth industry. Companies have no control over the death rate, leaving them with limited options to increase revenues and earnings beyond such methods as incremental price increases, acquisitions, and operating margin expansion.

Most of the funeral companies under our review pay a regular quarterly dividend and have the ability to implement annual increases. Above-average dividend yields are common, and limited partnerships, paying out investment income, often have the most generous payouts. There is substantial debt in the industry, somewhat pressuring finances, but cash flow is usually sufficient to cover both the maintenance of ongoing operations and the distribution to stockholders.